Econ 101: Government Interventions – Part Three

In this final piece on Government Interventions, I want to highlight some of the many ways that governments interfere in the free market. Regulations, taxes, tariffs, subsidies, and bailouts are all governmental actions that have a distorting effect on the market and that cause producers and consumers to act differently than they would have without those distorting influences. Let’s start with regulations.

Whether or not a regulation is perceived by the public to be good or bad overall, it will necessarily change the behavior of the regulated company or industry. Costs of complying with the regulation will tend to reduce the profits of the regulated company, resulting in unemployment for the least productive workers in the company or higher prices for the consumer or, most likely, both. I have heard industry-wide regulations justified on the grounds that they “create a level playing-field” for the producers in the regulated industry. But this is simply not true. A large company with a big share of the market already has an advantage over a smaller company in an industry, and so a regulation affecting them both will obviously be more harmful to the small company than to the large. In fact, many if not most regulations are actively endorsed by larger companies because they know that small competitors will be harmed more than they will, which may help weed out some of that competition and thus further increase their market share. Over time, the cumulative effect of regulations will be to concentrate market share in a few large companies within the regulated industry because the compliance costs are simply too great for smaller companies to remain profitable or even to get started in the first place. Examples in today’s world would be the oil industry and the radio industry, where small companies tend to struggle and new entrants to the market are rare these days.

I talked about the distorting effects of taxes in Part 1, so I won’t go into that again much here. I only want to add that not only do taxes take money from taxpayers to spend on things they wouldn’t have purchased, but corporate taxes and sales taxes also raise the price of the things the taxpayers do purchase.

Tariffs are a subset of taxes, specifically a tax on goods imported into (and sometimes on goods exported from) a given country. The purpose of the tariff is generally to raise the prices of foreign goods relative to domestic goods. In other words, a tariff tries to keep the people’s money at home, rather than allowing them to spend it on what they want from wherever they want.

A subsidy is money granted by the government to a company, justified as an effort to “assist an enterprise deemed advantageous to the public.” A bailout is just a particularly large one-time subsidy, assisting the enterprise in question by preventing it from going bankrupt. I hope it’s obvious that the government giving money to any company creates a distortion of the market, but here are a few reasons why, just in case it’s not. For one thing, the company can now charge less for its products or services than it would have because the government is making up the difference in revenue. So subsidized companies will have that advantage over unsubsidized ones. However, this also allows inefficiencies in the company to go “unpunished” by the market, since the incentive to economize is diminished by the free money from the government. For the consumer, the net result tends to be lower quality without much lower price.

There are literally hundreds, maybe thousands, of specific examples of governmental market distortions that could be cited, but I just wanted to convey some of the broad categories to illustrate the economic effects of government actions. Many times regulations, taxes, and subsidies are discussed in the news in terms of fairness or need, but the economic effects are almost never mentioned or else are glossed over. My personal view is that, if a government at any level is thinking of adopting a policy, it should not be afraid to consider the effects that the policy will have on the economy. It should consider the probable costs as well as the possible benefits. And once it has considered this, for the reasons mentioned above and in the previous article, it should expect that it has underestimated those costs.